The New Economics and Canada, Speech for the Association of Professional Economists of BC (Victoria -- 29 May 2012)
I would like to thank the Association of Professional Economists of British Columbia for inviting Taeko and me here this afternoon.
I consider it a great honour and privilege to be here today.
In my professional life, I had the chance to start my career in a country as an investment bank economist – Japan – that most investors and professional media could not understand.
It was my job to explain first how Japan the country worked as a means to explain how the Japanese economy worked.
Thinking about the economy in terms of components of GDP and prices might be convenient but it was never very instructive.
Instead, the role of geography, history, politics, culture, and personality in shaping the Japanese economy were keys to my analysis.
I subsequently came to the view that this applied to every country.
For example, in the phrase the German economy, there is more information in the word ‘German’ than in the word ‘economy’, as in the ‘Japanese’ economy, the ‘Canadian’ economy, and so on.
I think that the market is a theoretical place where people freely trade their labour and genius for personal profit while the economy is what geography, history, politics, culture, and personality make of the market.
Explaining the difference between the deflation bias in German, and inflation bias in American, 20th century monetary policy, doesn’t really require much more than a picture of a Berlin housewife with a wheel barrow full of Marks on her way to buy a loaf of bread in 1923 twinned with a picture of Kansas farmer’s wife with three kids in front a beaten up old truck on their way to California in 1934.
This may help put my comments today into some context.
I would like to divide my talk into three parts.
First, I would like to discuss the study of economics in broad terms to help reframe the debate about the economy, social justice and the environment that views them as ‘obligate symbiotic’, parts of the same whole that depend on each other for their mutual survival.
Second, I will briefly review the outlook for the Euro zone, the United States, and China.
Finally, I will speak about immigration and tax policy in Canada.
If there is one message I hope to leave behind today it is that economics must be a ‘moral enterprise’ as much as politics claims to be.
I think that economic outcomes need to be framed in terms of right and wrong not just efficiency if only because these two goals often align in surprising ways.
Eric Beinhocker in The Origins of Wealth demonstrates that the study of economics got off to very bad start in the later part of the 19th century from which it is now only just recovering.
Beinhocker argues that “the mainstream paradigm of economics over the past hundred years has portrayed the economy as a system that moves from equilibrium point to equilibrium point (p. 17-18)” like a ball in a bowl that eventually settles at the bottom.
This view of economics was rooted in the belief that “a science of economics was available for discovery with the power of mathematical tools that was as predictable as physical phenomena like gravity and the speed of light.”
Of course, if this approach was valid than human beings must be “logical and consistent in their behaviors (p. 37).”
Unfortunately for economics, human beings are predictable as Roberto Luongo.
A problem for economists was the belief in economics as pure science forced economists to make predictions.
While economists forecast often what they forecast is rarely right, and when it is right, often it isn`t very interesting because it is obvious.
I took to dealing with this professional absurdity by telling clients that I felt my job as Chief Economist as well as head of equity research was to be ‘100% memorable and 51 % right’.
This caused my bosses at RBC and Lehman – excluding Tony Fell and Fred Fraenkel – no end of angst.
This even when I explained that trying to be 100% right would only be possible by forecasting what is known, and therefore useless to generate alpha as the market had discounted the outcome.
However, by holding myself to the very strict discipline of being 51% right while trying to being 100% memorable meant that the market had not yet discounted the investable action thus making it possible to achieve above benchmark returns.
Like many Bay Street economists and strategists it was always tempting to turn forecast dinners into comedy routines because no matter how serious the form, the substance of economic forecasting is always humorous, because as everyone in the audience knew the only function of economic forecasting is to make astrology look respectable.
But thankfully economics has not stayed still.
Over the past couple of decades economics conceived in terms of Darwinian natural selection – evolutionary biology -- the alternative model rejected for physics in the 1880s has recently become a model for thinking about how economies actually work.
Just as the process of ‘differentiation, selection, and amplification’ has driven the ecological process which results in mind numbing natural diversity, monopolies of species, and great extinctions in the natural world so it is in the economic world.
The key idea is that efficient economic systems are in a constant state of flux and adaptation, and that the most successful economies all have one thing in common, no equilibrium.
Equilibrium for an economy is only possible if it is imposed by the state expressed through religion, and sometimes because of geography or politics.
To paraphrase an old Woody Allen joke, an economy is like a shark, it has to keep moving forward to stay alive, and where there is equilibrium you will soon have a dead shark.
Brian Arthur calls the research that falls into this body of work ``Complexity Economics`` where the economy and the society are in a constant flux of boom and bust driven by innovation.
But unlike the fictional intelligent designer in the natural world in the economic world much depends on human intervention that may or may not be intelligent.
Economies can be steered to different outcomes with strategic intervention changing the Darwinian calculation from natural to calculated evolution, and the results can be good and awful.
With that background I would like say a few words about the Eurozone, the United States, and China.
The outlook for these countries is lousy but for different reasons.
As is well known, Europe is in the grips of a balance of payments crisis from which it cannot adjust.
This is the consequence of the Euro which has been exposed as politics masquerading as economics.
The political incentive to twist the economics of a European currency union, whatever the consequence, is a function more of a fear of history than any promise of productivity.
The legacy of wars and division, fear of a German Europe instead of a European Germany, has led normally rational commentators to ignore the flaws imbedded in European monetary union.
In addition to the well-known problem of the lack of a real fiscal union, and the unintended consequence of the Euro project bankrupting Europe’s banking system, countries like Greece and Italy are structurally uncompetitive and are trapped by a currency they cannot afford.
These countries are only going to be crushed by ongoing rounds of austerity something voters in Greece and France have figured out.
No one really knows how it will all end but it will be messy.
The United States not only faces downside risks from the euro crisis, it must also contend with fiscal drag, deleveraging in the household sector amid weak job creation, stagnant incomes, and persistent downward pressure on real estate and financial wealth, rising inequality, and political gridlock.
The US is also paying the price for a protracted period of under-investment in best in class justice, education and health outcomes, and tolerating Great Gatsby-like widening income inequality.
Arguments against investment instruments of social justice are framed in terms of the moral hazard that this creates for individuals who are better off ‘on their own’ without the help of an intrusive state.
Deeply imbedded in the cultural make-up of the United States is the belief that there is no such thing as a ‘hand up’ only a ‘hand out’ except in the case of citizens that have served in the military.
However, the OECD has shown that the US has one of the worst records of inter-generational mobility.
This record belies the argument that American society rewards hard work and enterprise above all, and that where you start in life is less important than how hard you work.
The American combination of economic insecurity, social inequity, and minimal government welfare support is proving to be a model incompatible with competing in the present day global economy.
The persistent underinvestment that the United States has made in primary and high school education has left the country with an estimated shortage of 2 million skilled workers while those without skills are stuck in a permanent unemployment limbo.
Moreover, anyone travelling to the United States will notice the consequences of underinvestment in roads and bridges, ports and airports.
The American Society of Civil Engineers estimates that this underinvestment cost the economy $130 billion in 2010 because of higher running costs and travel delays.
The United States has begun the process of losing part of a generation of economic growth.
The deep flaws in China’s growth model are becoming obvious.
China’s outsized unequal economic results and withered civil society underlines that these types of outcomes are not just confined to countries where politics are market driven but also where the markets are politically driven, perhaps more so.
China has four very big problems.
First, China’s tremendous bias to savings, investment, and exports, coupled with the financial, manufacturing, communication, information and transportation improvements in the global economy, at the very moment that China developed, has led to investment as a percentage of GDP to reach a level not seen anywhere before, a level well over 45%.
Driving this colossal rise in investment is a state directed banking system that floods money into capital rich projects divorced from any market discipline and supervised by local party officials.
Second, the crushing of the democracy movement in 19-89 resulted in the re-assertion of the Communist Party over the economy symbolised by the rise of state owned enterprises.
The stories of corruption, price fixing, and illegal activities that constantly crop up are rooted in the privileged group of people who run these state owned firms and the long line of people behind them who benefit mostly family and friends.
It is remarkable how the closed, authoritarian, economically manipulated economies capture our imagination, countries that for a time seem invincible but ultimately, cannot find the keys to sustainability, which are openness and flexibility because there is a deep political and social bias against change.
Third, China’s economy will slow because the easy part is over.
Growing from a low to a middle income country is much less challenging than moving to a high income country particularly when income inequality is so vast and political control of the economy so great.
Finally, China will become the world’s fastest ageing country by 2020 no matter what it does to inflect its fertility rate up in the next decade which will cause the labour force to start shrinking soon.
China’s preference for boy babies over girl babies has resulted in the greatest imbalance between males and females in recorded human history: China is short about 35 million women.
So what of Canada?
Well rather than leave you with the simple conclusion that the Canadian dollar and the TSX will be weaker by about 10-15% because the country’s economic momentum has become so resource driven, I would like to suggest that Canada has a tremendous opportunity to move forward while so much of the world is moving backward.
The fact is that Canada is geographically vast, sparsely populated, is next door to history’s most powerful country, and has spent two centuries consistently finding peaceful solutions to including a distinct language and cultural population situated in the geographic heart of the country.
Canada has become a sophisticated, bilingual, peaceful, open, wealthy, and increasing urban country whose growth is significantly driven by the success of the children of new Canadians competing in the global economy.
Canada is one of the few developed countries that can double the size of its population by mid-century by slightly elevating current fertility rates and per capita immigration levels from the current average annual population increase of 1% to 1.2%.
Just imagine 60 million Canadians by 2050!
Already at current trends, Canada will pass Germany in total population by 2070 and Japan by about 2080.
The biggest challenge for Canada in the 21st century is how to ensure that an immigrant fueled rise in our population is consistent with best in class justice, education, health, economic, community and environmental outcomes.
Seizing this opportunity begins with a hard headed assessment of best in class immigration strategies.
First, the bad news.
Canada’s record at integrating immigrants has deteriorated over the past 15 years relative to some peer countries that also have high per capita immigration levels like Australia.
There has been a widening gap in earnings between immigrants to Canada and the Canadian born.
For example, immigrants who arrived between 1987 and 2004 have incomes that were on average equal to only 70 per cent of the incomes of Canadian birth.
These immigrants also have higher than average levels of unemployment, lower labour force participation rates, and disproportionately have incomes below the official poverty line.
In Australia’s case an emphasis since 1999 on English-language capability and a pre-arranged employment contract for immigrants while streamlining the approval process has had a significant positive impact on economic and other key outcomes.
It does not take much imagination to conclude that someone coming to Canada who is functional in English and has a pre-arranged job is more likely to integrate into the country at wage levels consistent with the rest of the population.
To make sure Canada’s immigration strategies create a permanent advantage Canada must commit to world class immigration policies that emphasize official languages, employment, and speed.
The good news is that the first born generation of immigrants have average education and economic outcomes similar to second and other generation Canadians although this is tilted more towards women than men.
This important achievement is a consequence of four things.
The first three reasons are the immigration points system, family unification policies, and Canada’s best in class instruments of social justice that create the conditions for high levels of inter-generational mobility.
The points system which puts an emphasis on education attainment as a condition for entering Canada means that first born Canadian children are being raised by parents that have higher average education levels that native Canadians.
Consequently, Canada is one of only two OECD countries where the first born generation of children perform as well as children born to native parents in math and reading tests for 15 year olds.
The reason for the importance of family unification is perhaps less obvious.
Immigrants to Canada have very few networks of support on arrival a problem that is a huge issue for non-working spouses and children.
Having an extended family creates an emotional, health and education safety zone for family members particularly for children where both parents work.
Having a doting grandparent, aunt or uncle at home with a good meal and a stern eye to studying is of incalculable importance in creating best in class education and health outcomes.
The third reason, instruments of social justice, help create the conditions for intergenerational mobility which means that immigrant earning deficits are not transferred to their children.
There is no one size fits all economic and political strategy that guarantees a country’s success but everywhere the challenge is to ensure that citizens can adjust to the impact of new technologies.
Unfortunately, the seizure of political power by either market or state fundamentalists has typically undermined the centrality of small ‘l’ liberalism as a defining thesis for shaping societies and preparing their citizens to adjust to new technologies and globalisation.
By liberalism I mean the belief that individuals are of equal worth, that citizens are made not born, and that the circumstances of a person`s birth should not be the key determinant of a citizen`s life path.
Liberalism takes the view that the state has a vital role in regulating the market and taxing citizens so that there are no significant barriers to how high someone may rise, a line below which no citizen can fall, and a timeless effort made to create the conditions of equality of opportunity for all citizens no matter how imperfect the process, and the right balance between economic, social and environmental justice.
I think that this is even more important because over the past 30 years the speed and the reach and the impact of globalisation accelerated to the economic equivalent of something approaching the speed of light.
The hand wringing about capitalism as being too hot where the market dominates or too cold where the state dominates misses the truth that ultimately the most sustainable communities find the balance between the twin virtues of inequality of outcomes and equality of opportunity.
The trick is how to tax and regulate the economy in such way as to ensure unequal economic outcomes provide the public revenue to invest in instruments of social and environmental justice, namely equality under the law, world class public education and public transportation, the science of good health available to all citizens, and best in class environmental outcomes.
And the fourth reason for Canada’s immigration success?
Complexity economics gives us a framework to understand the subtleties of how economies work in a way that market-centred economists often miss.
For example, the consequence of immigration is greater than a multiplier of the number of people.
The evolution of the economy and our society is helped immensely by immigration because of the invigorating introduction and weaving of different languages, skills, customs, tastes, and philosophies.
One proof is the fact that immigrants have a significant and positive impact on innovation and not just because of their higher education levels.
Not only do immigrants patent at a higher rate than the native rate but there is evidence of a spillover effect as per capita patents increase in response to an increase in immigrants.
As innovation author Jonah Lehrer puts its “ages of excess genius are always accompanied by new forms of human mixing.”
More subtly perhaps is the twin of ‘the invisible hand of the market’ that I call the ‘invisible hand of social justice’.
Can it be that striving for equality of opportunity however imperfect the process not only benefits the individual but creates benefits for the society as that are unintended but also often wonderful?
A few weeks ago the Economist reported that an Professor at MIT had quantified that an infusion of hope made possible by a small monetary incentive can make a huge difference to the lives of the wretchedly poor.
It was demonstrated that the effects of some anti-poverty programmes go beyond the direct impact of the resources provided because they make it possible for the very poor to imagine a life beyond mere survival.
This created an incentive to live a safer and more productive life.
The invisible hand of social justice weaves citizens into a common place brought together, not by privilege or invitation or class or ethnicity, but by shared experiences.
People learn to help each other leading to better outcomes for everyone where trust not money is most important social currency.
How then to break through the shackles of market-centred fundamentalism, the legacy of a 120 years of falsely conceived economics, and an intrusive all-knowing state, the fallout of 20th century liberalism?
I would like to suggest the following changes that might help Canada in the 21st century.
Within the framework that a strong economy, social justice and environmental responsibility are mutually dependent, I would suggest we consider the following package of tax reforms: first, eliminate all corporate taxes; second, eliminate all taxes on the first $20,000 of personal earned income; third, adopt a guaranteed annual income based on Milton Friedman’s idea of a negative income tax; fourth, establish a carbon tax; fifth, raise the GST to 10% with no exceptions; and sixth legalise, regulate, commercialise, and tax marijuana.
The case for eliminating corporate taxes recognizes the fact that when you tax a company you actually tax people, the owners, the employees, and their customers because a tax is a cost.
In the rapidly globalising economy of the 21st century the ability to host strong and profitable companies will be even more important in order to take advantage of technological disruption.
Nothing can match well regulated and profitable companies for providing the pathway to personal and national prosperity.
This is what Adam Smith argued in The Wealth of Nations.
The lesson of the 20th century is simple, let the state regulate, and in most things, let the market operate.
Moreover, with no corporate taxes, there are no write-offs and the expensive bureaucracy -- private and public -- required to manage it.
Paraphrasing Richard III: ‘The first thing we do, let's kill all the accountants’.
One simple step to end poverty is to provide a basic income to every Canadian if only because of the high cost of persistent worst in class education, health, community and economic outcomes that poverty breeds.
This is an issue that cuts across political stereotypes as Conservative Senator Hugh Segal and economist Glen Hodgson of the Conference Board of Canada are important advocates of a guaranteed annual income.
The idea of guaranteed annual income in Canada was first floated in the 1930s and a pilot project in Manitoba in the 1970s demonstrated that some of the fears about work disincentives proved false while the positive impact on health proved true.
The obvious direct benefits are that income poverty would be eliminated immediately and the cost of delivering anti-poverty programmes would be reduced dramatically.
This of course is the reason that Milton Friedman argued that if you were going to assist the poor rather than building up a huge and expensive public sector bureaucracy to manage the moral hazard of welfare better to just to write a cheque as part of the tax process.
Again paraphrasing Richard III: ‘The second thing we do, let's kill all the welfare workers’.
The indirect economic benefits might include the removal of market distorting income policies like the minimum wage.
At the same time eliminating taxes on the first $20,000 of income would provide an important incentive to encourage people to earn more than the guaranteed annual income, help shift taxation from income to consumption, and cover some of the cost of the changes to the GST for the poor.
University of Toronto economist Michael Smart has recently shown that raising the GST to 10% without exceptions would raise about $70 billion in revenues representing a $40 billion increase over the current 5% rate with exceptions on things like food, medical devices, rent, and education.
This change would make the tax system more efficient, and despite concern about being regressive, a 10% rate would put Canada far at the bottom of the table of the most progressive countries that depend on a consumption tax to fund sustainable instruments of social justice.
We should speak plainly and often to Canadians about the damage done to the country’s finances by the current Prime Minister’s politically motivated but economically irresponsible cutting of this tax, dumb because the revenue loss was so large that it baked in a deficit once the economy slowed, and dumber because it made the tax system less efficient.
The case for the legalisation, commercialisation, and taxation of marijuana is gaining momentum.
Canada ought to seize the chance to save billions of dollars in the exercise of law and order while creating new businesses and tax revenue while giving adults liberty about how they choose to numb themselves.
Finally, as the science of global warming is widely accepted, Canada should lead the development and dispersal of new technologies by establishing a carbon tax.
By way of example, the Liberal Party’s Green Shift estimated that at $40 a tonne a Canadian carbon tax would raise about $15 billion.
Neither the economy nor social justice will be served if we continue, as Robert Wright has argued, to place a ‘murderous burden’ on the planet.
In conclusion, given the challenges ahead of us, economic, political, social and environmental, as professional economists you have, I think, a duty to to frame your answers to these challenges as questions of morality as much as questions of efficiency in the true tradition of the first great political economist Adam Smith.
These policies could make Canada better able to adjust more profitably and responsibly to the tumultuous impact of new technologies in a way that turns the evolution of the economy more and not less to our common advantage.
A prediction perhaps, that’s 100% memorable; and maybe, 51% right?
‘Societies that began with extreme inequality evolved highly unstable political institutions reinforcing that inequity and provoking constant conflict.’ – Niall Ferguson
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